Working Paper: NBER ID: w26056
Authors: Michael T. Belongia; Peter N. Ireland
Abstract: In the 1920s, Irving Fisher extended his previous work on the Quantity Theory to describe, through an early version of the Phillips Curve, how changes in the money stock could be associated with cyclical movements in output, employment, and inflation. At the same time, Holbrook Working designed a quantitative rule for achieving price stability through control of the money supply. This paper develops a structural vector autoregressive time series model that allows these "classical" channels of monetary transmission to operate alongside the now-more-familiar interest rate channel of the New Keynesian model. Even with Bayesian priors that intentionally favor the New Keynesian view, the United States data produce posterior distributions for the model's key parameters that are consistent with the ideas of Fisher and Working. Changes in real money balances enter importantly into the model's aggregate demand relationship, while growth in Divisia M2 appears in the estimated monetary policy rule. Contractionary monetary policy shocks reveal themselves through persistent declines in nominal money growth instead of rising nominal interest rates and account for important historical movements in output and inflation.
Keywords: business cycle; monetary policy; classical view; New Keynesian model
JEL Codes: B12; E31; E32; E41; E43; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| contractionary monetary policy shocks (E39) | reductions in nominal money growth (E49) |
| reductions in nominal money growth (E49) | reductions in inflation (E31) |
| reductions in nominal money growth (E49) | reductions in the output gap (E23) |
| changes in real money balances (E41) | aggregate demand (E00) |
| contractionary monetary policy shocks (E39) | reductions in inflation (E31) |
| contractionary monetary policy shocks (E39) | reductions in the output gap (E23) |
| reductions in inflation (E31) | economic activity (E20) |
| reductions in the output gap (E23) | economic activity (E20) |